Question: Please give me detailed solution of this problem. (AMS 318 book: Mathematical Interest Theory Second Edition)
(Question) Suppose that the Johnson family has the option of purchasing two bonds.
• Bond A is a $4000 10% 10 year bond paying annual coupons with redemption value $2000, which can be purchased at a premium for $3000.
• Bond B is a $4000 1% 10 year bond paying annual coupons with redemption value $6000, which can be purchased at a discount for $2000.
Suppose further that each bond is callable and has a lockout period of 5 years, after which a call option can be placed by the issuer at the end of years {6, 7, 8, 9} for call premium of $2000.
(Assignment)
Compile a technical report for the Johnson family which:
1. Briefly explains the cash flow promised by each bond to the investor.
2. Briefly explains a call option, and when it is likely to occur for each bond.
3. Lays out the resulting APY afforded from each bond, after the call option (if any) is placed by the issuer.